The Canberra Times published today an opinion piece of mine on a topic I have been writing about since late November and is familiar to Club Troppo readers. My original version is set out below. For various reasons, I may not be able to respond to comments quickly. Sorry.
The economic outlook is uncertain. The Rudd Government needs to prepared for a worst case scenario involving a serious economic slow-down and unwelcome increases in unemployment at least in some states – over the next two years.
The employment situation, while much improved on what it was a decade ago, is still far from satisfactory. Australias labour force participation rates are below the best in international terms and, after allowing for under-employed and discouraged workers, the actual under-utilization rate is closer to 7% of the workforce than the official rate of 4%. So there is no justification for accepting a marked increase in job-seekers as inevitable..
If the economy weakens markedly, monetary policy will probably do its part to revive the economy but the impact lags are unpredictable. It is quite likely that the multiplier effects of a monetary stimulus are greater than for a fiscal stimulus but the two can usefully complement each other if there is a risk that an economy will run into a recession. Fiscal and monetary stimulus together may provide broader support for the economy than monetary policy actions alone.
A recent US academic review of the empirical literature on how best to craft fiscal stimulus concluded that, provided a discretionary fiscal stimulus is seen as temporary, it would boost economic activity more quickly than monetary policy and would usefully supplement and reinforce any monetary stimulus. It added that when the impact of policy instruments is not known, policy makers should use all the instruments available. Australias own recent experience with fiscal stabilization policy has generally been OK. It has played a good supportive role at times e.g. in 2001 and 2004.
Well used, fiscal policy can clearly be effective as a contra-cyclical tool but its biggest stumbling block is implementation lags, especially in periods when governments do not control the Senate. How do we get around that?
One possibility would be for Parliament to give to the Government authority to temporarily decrease the GST (or some other consumption taxes) within a narrow margin without requiring legislation subject to the original GST rate being restored over a five-year period. The authority could extend to flat tax rebates now being used in the USA and likely to have desirable effects on job formation there – tax credits for business investment (presumably of temporary duration) or a temporary increase in unemployment benefits or household tax offsets.
If there is a threat of recession, the Government could also spend some money usefully on correcting the constraints on labour mobility (occupational and regional) and the inequalities of employment opportunity. These adversely affect the unemployment/inflation relationship, which is more responsive to structural change than to traditional monetary tightening. With political constraints on further wage flexibility, active government measures are needed to enhance the competence, employability and locational opportunities of low-skill low-ability workers and to prevent the perpetuation of chronic inter-generational joblessness. Such measures have been successfully applied in Nordic and European countries.
But the most rewarding idea would be to have a number of sensible ready to go infrastructure projects for quick implementation. The advantages of such a proposal are potentially very large.
First, spending increases on projects with reasonably short gestations can produce a more effective contra-cyclical demand effect per dollar than tax changes because it initially raises aggregate demand in the economy dollar for dollar, whereas a share of the tax cut is saved.
Secondly, the benefit cost ratio on any new infrastructure project is much more favourable if it is started at a time when there is a lot of spare capacity in the engineering and construction industry than at a time of full employment.
Thirdly, investment spending has much bigger spin-offs for the economy in the long term than increased transfers and consumer spending e.g. it offers an opportunity to rectify the past neglect of economic infrastructure such as ports as well as social and environmental investment in education, health, public transport, low-cost housing, urban roads, rivers and water.
If the slowing of activity in the private sector goes too far and starts to seriously threaten jobs, it will surely be a never-to-be-missed opportunity for governments to start fixing our long-neglected public infrastructure while at the same time addressing the cyclical problem.
But if investments are to be well timed and productive, governments need to be institutionally prepared. In particular, there needs to be prior federal state coordination and a national audit to determine priorities. This can be done through COAG or the new Infrastructure Australia body. There also has to be a mechanism in place for quick implementation (which is why prior parliamentary authority for limited action would be helpful).
There should be no objections in terms of political credibility. The Rudd Government commitment is to achieve a budget surplus on average over the business cycle. This gives Wayne Swan the moral justification to run a significant budget cash deficit for a period in the right economic circumstances.
By all means let’s cut out fiscal waste in the 2008/9 Budget but the Government should be prepared for a quick turnaround if economic circumstances change dramatically.